The new Foreign Investment Law (FIL) and the beginning of a new era for foreign investment in China - Part 1

The past few months have been extremely difficult for the world

economy. The media floods the airways daily with worrisome

news about the impact of the COVID-19 pandemic in international

markets.

But in the mist of all of this, business professionals interested in investing in China have good news.

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The new Foreign Investment Law (FIL), which took effect on January 1, 2020, levels the playfield and allows foreign businesses to compete more fairly in the Chinese market. The new FIL and related regulations mark the beginning of a new era for foreign investment in China.

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The legislation establishes a new legal framework for the management and promotion of foreign investment. Foreign investors and their subsidiaries in China will need to stay abreast of and familiarize themselves with the new regime in order to comply with and benefit from it.

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The new FIL symbolizes the shift from the old foreign investment system to reflect the modern market access centered around the Negative List system. The FIL, considered a framework guiding future foreign investment legislation, addresses some of the biggest challenges facing foreign investors: intellectual property rights, forced technology transfers and equal treatment in government procurement between local and foreign enterprises.

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The FIL replaces three laws on foreign investment, including the law on Sino-foreign cooperative Joint ventures (CJV), the law on wholly foreign-owned enterprises (WFOE/WOFE) and the law on Sino-foreign equity joint-ventures (EJV). This means that the distinction between WOFE, EJV and CJV will no longer exist.

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The new legislation serves as the basic law, prescribing the basic principles of foreign investment in China. Foreign enterprises will be subject to the same domestic laws as Chinese companies, being the Company Law and where applicable the Partnership Enterprise Law. The FIL also unifies the governance of more forms of foreign investment, such as M&A (merger and acquisition) and new project investment, rather than just the establishment of Foreign Invested Enterprises (FIEs).

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The Implementing Regulation provides additional details and clarity on several general provisions and principles set out in the FIL. This regulation requires national treatment for FIEs in many important areas, including government funding, land supply, tax reductions and exemptions, permitting, standards formulation, public procurement, and project approvals.

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It also sets out the rights of FIEs to participate in rule-making, standards formulation and government procurement; and requires government authorities to take measures and establish systems for transparency in rule-making and administration, providing consulting services and guidance for foreign investors and FIEs, and handling complaints by FIEs or their investors.

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Similarly, it provides further details regarding expropriation of foreign investors’ investments, protection of intellectual property, the new “negative list” system for administration of the establishment of and changes to FIEs, information reporting, and the transitioning of existing FIEs.

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Some reports speculate that the implementation of the new FIL is an attempt by the Chinese government to respond to international criticism from the United States and others about China’s limited openness to foreign businesses.

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China’s accumulated foreign direct investment (FDI) exceeded US$2.1 trillion by the end of 2018, ranked second in the world according to the United Nations Conference on Trade and Development (UNCTAD). Yet, according to World Bank’s 2019 “ease of doing business” index, China’s score ranked 31 in the world, still behind many countries such as the United States, Malaysia, Germany, and Russia.

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Some ASEAN countries such as Thailand, Malaysia, the Philippines, and Vietnam have made improved efforts to win FDI away from China by providing an alternative when it comes to capturing shifts and movements in foreign companies’ supply chain and sourcing activities. Though these countries could attract an incremental amount of FDI, not many FIEs left China given the massive opportunities in the local market.

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For this reason, China needed a law like the FIL to demonstrate its commitment to a more open and transparent business environment for foreign investment, while the three existing laws no longer supported the economic growth envisioned by the Chinese government.

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These corporate establishment structures were announced between 1979 and 1990, the early years of China’s economic opening. With China’s economic growth slowing down, and ASEAN’s rise as an alternative FDI destination, China needs a more welcoming investment climate to remain competitive. In this context, China needs a modern, unified law to reflect its new economic structure and assure the foreign investment community about the incentives associated with investing in the country.

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As a legislative effort to improve the foreign investment climate, the new FIL shows China is getting more serious about protecting investor’s rights. The law puts emphasis on equal national treatment of foreign investment, offering foreign investors a more level playground with domestic investors, and giving them equal protections.

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In addition, the new law could help create a law-based environment to protect foreign investor’s legitimate rights and interests, which is closer to international practices.

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With the new law, the local government has to standardize their administrative actions on foreign investment and make sure their officials act lawfully. Illegal behavior by officials – such as the misuse of authority, neglect of duty, self-seeking misconduct, and disclosure of trade secrets – may result in criminal charges.

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The violation of intellectual property in China has been for years one of foreign investors’ main complaints. The new FIL not only protects it but orders government agencies to maintain the confidentiality of the trade secrets of foreign investors.

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Moreover, the unified governing law for foreign investment could help reduce confusion for new foreign investors in the future, easing the process of investing and doing business in China.

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A combination of the FIL and the “Phase One” U.S.-China trade deal could also spur a new wave of interest and ultimately FDIs in China. A large amount of American companies that were paralyzed by the trade war, did not want to implement any China changes and at the same time did not want to invest in alternative jurisdictions until there was some sense of resolution in the dispute. The new FIL will provide legal protection and a more robust framework for this trade deal.

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In a similar way, the FIL could help China remain competitive among other alternative FDI destinations, particularly in the ASEAN region. Though FDIs into China have not slowed down, they are focused on specific sectors such as trading, providing services, and manufacturing operations “in China for China.” There have been major investments in local retail and distribution channels, in the medical and health care sectors, e-commerce, IT as well as a few financial sectors, which have recently opened to larger or even total foreign participation.

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Due to the ban of forced technology transfer and further IP protections, experts predict that China could attract more FDIs in high-tech industries such as technology, communication, information transmission, fintech, software, and information technology.

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Foreign investors planning to set up new operations in China will have to set up their business in accordance with the laws applicable to domestic investors such as the Company Law and the Partnership Enterprise Law, among others. The biggest impact for FIEs will be to adjust their corporate structures to be compliant with these laws.

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FIEs will have a five-year period to comply with the new legislation, starting January 1, 2020. If the FIE fails to make the necessary changes within the five-year transitional period, it will have another 6 months of grace. If after that time it fails to implement the changes, the government will no longer be able to accept its applications for other corporate matters and may notify the non-compliance through the Enterprise Information Publicity System.

Should you have questions about the Foreign Investment Law, complete the below inquiry form with your questions and comments.

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DISCLAIMER: All information in this ebook is verified to the best of our ability and is assumed to be correct at time of release; however, Woodburn Accountants & Advisors does not accept responsibility for any losses arising from reliance on the information provided within. The information provided is for general guidance and does not replace specialized advice.